Negative-yielding bonds: Why buy them? Why sell them?

Henkel and Sanofi broke new ground this week in selling negative-yielding bonds in Europe

by: Gavin Jackson


This week two public companies took free euros offered to them by investors, when they became the first to sell bonds with a negative yield-to-maturity.

Henkel, a German maker of Persil laundry detergent, sold €500m of two-year bonds with a yield of minus 0.05 per cent while Sanofi, a French pharmaceuticals manufacturer, sold €1bn of three-and-a-half year debt with a yield of minus 0.05 per cent.

Some eurozone government bonds have traded at prices which imply negative yields for two years, but lending to companies is supposed to be much more risky. The sales from Henkel and Sanofi are the latest step in an incremental process where more and more risky types of debt start to be sold at negative yields.
How can debt be negative yielding?

A bond is a promise to pay a principal and a coupon. Principal is what lenders get when the debt is repaid, while the coupon is a regular interest payment due to the bondholder.
 
As coupons and principal payments are fixed at the time of issue, the market price of the bond will fluctuate depending on how attractive its income is when compared with other bonds. An investor may pay £110 for debt with a face value of £100.

The way bonds are compared in the market is by their yield, the effective income from buying the bond at its current price. So the higher the price, the lower the yield.

For negative yielding bonds, the market price is greater than the remaining coupon and principal payments. If an investor holds the bond until it matures, they will lose money.



 
Why would people buy negative yielding debt?

The European Central Bank cut its deposit rate below zero for the first time in 2014. This is the amount commercial banks are paid (or rather, they now pay) on money they leave overnight at the central bank.

Banks have passed this cost on to customers, particularly companies and pension funds with large account balances. In March, the ECB cut the deposit rate even lower, to minus 0.4 per cent.

The cost of leaving their cash on deposit with a bank has led companies and investors to seek out other safe assets. Bonds with negative yields become attractive, so long as these yields are less punitive than those for keeping cash in the bank.

Short-dated investment grade corporate bonds, while still offering negative yields, pay more than cash (and government bonds) as well as being relatively safe.

Additionally, some investors may speculate that yields can fall even further, which will push up the prices of corporate bonds. So investors in the Henkel and Sanofi bonds may be able to sell them on at an even higher price later.

One reason to think yields could go lower it that the ECB is buying corporate bonds. One of the criteria for bonds being eligible for such purchases is they must yield more than the ECB’s deposit rate of minus 0.4 per cent, leaving room for the central bank to change its criteria and buy debt with a more negative yield.

What does the ECB hope to achieve?

The ECB’s ultimate goal is to boost inflation and growth in the eurozone. By lowering the cost of financing it can help persuade companies to spend more money and ldirectly lift demand.

However corporate treasurers say that small changes in the interest rate are unlikely to make much difference to their investment or strategic plans like acquiring a competitor.

But the ECB also has in mind something called the “portfolio rebalancing effect” which means investors shifting their asset holdings away from very safe and unproductive assets, like cash, into riskier assets like corporate debt.

Having cash is a problem for banks, investors and companies as this means finding something to do with it and passing it on to someone else to spend.

And now Henkel and Sanofi themselves have this problem. Having sold negative yielding debt, they now hold even more deeply negative-yielding cash on their balance sheets. While they are being paid to borrow, they pay even more to sabe.

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